Investing In Steel: The Definitive Guide

Steel has been known to mankind for thousands of years; its use dates back to the 1700s and has played a key role in human infrastructure. While new stronger metals—like titanium—have since developed, steel is the most cost-effective option for building products, and it remains in high demand worldwide [for more gold news and analysis subscribe to our free newsletter].

Steel has also become popular among traders and investors, providing a way to profit from economic growth and infrastructure investments. Although investors cannot achieve physical exposure to the product, they can buy futures contracts of a wide variety of steel types. Additionally, there are a number of companies that either process and make steel, or mine for the product’s key ingredient iron ore. This means there are multiple steel ETFs and individual stocks that allow investors exposure to the metal.

Physical Properties and Uses of Steel

First developed as long as 4,000 years ago in Anatolia, steel is an alloy that is commonly used in the construction of roads, railways, infrastructure, appliances and buildings as a supporting or reinforcing agent. Unlike the bronze or iron used before, steel proved to be much harder and stronger, and remains the most cost-effective solution in construction to this day.

While there are over 3,500 different grades of steel, commercial steel is generally classified as carbon steels, alloy steels, stainless steels or tool steels, based on the metal alloy content and commercial applications. Modern steel includes metal alloys like chromium (10% in stainless steel) in order to provide additional corrosion-resistant properties.

Steel Supply and Demand

Steel demand has been robust over the past several decades, as emerging markets like China and India continue their rapid industrialization. Between 1970 and 2011, global steel consumption tripled from 595 million to 1,518 million tons, according to the World Steel Association, with China accounting for approximately 45% of the demand [see A Deeper Look At China's Commodity Industry].

Country

2010 Production

2011 Production

China

637.4

683.9

Japan

109.6

107.6

United States

80.5

86.4

India

68.3

71.3

Russia

66.9

68.9

Global Total

1,429.1

1,517.9

*Data in millions of tons.

Unlike many other industrial metals, steel production and supply is well diversified, thanks to iron’s prominence worldwide. China, Japan and the United States are the three largest steel producers with production of 683, 107 and 86 million tons respectively in 2011. The largest companies in the space include ArcelorMittal (97 million tons) and Hebei Group (44 million tons).

The majority of steel imports and exports are in finished products, with the most popular exports being ingots and semi-finished materials, railway track materials, angles or shapes, concrete reinforcing bars, and hot-rolled bars and rods. Other products include everything from drawn wire to plates to steel tubs and fittings used in certain construction applications.

In 2011, approximately 31.4% of global production was exported, while the rest was used domestically, marking a secular rise since 1975 when just 22.6% of production was slated for export worldwide. The largest exporters in the same year were China, Japan and the European Union, while the largest importers were the European Union, United States and Germany.

Price Drivers

The steel industry is cyclical, highly competitive and has historically been characterized by overcapacity, making for somewhat volatile pricing at times. Moreover, the steel industry has been the subject of many tariffs and protectionist actions, including anti-dumping orders from Brazil and Japan, as well as similar allegations surrounding Russia, which can influence prices.

In general, the primary price drivers include:

Emerging Market Demand: As one can see in the list above, emerging markets dominate the list of the biggest steel producers. As citizens in these countries continue to reach the middle class, steel demand should be on the rise for a variety of products ranging from cars to cutlery. Investors should also look for any slowdown in these countries to adversely impact the steel market since steel production has seemingly topped out in most of the developed markets on the list above [see Inside China's Rare Earth Metal Industry].

Infrastructure and Transportation Demand: One of the key uses of steel is in the transportation and infrastructure industry. Steel finds its way not only into cars, ships, and railroads, but it is also a crucial component for general infrastructure. If global trade increases, steel demand seems likely to surge, but if the demand for ships, trains, and cars falls, investors should look for steel demand to plummet. Additionally, investors must consider the poor state of infrastructure in many countries, and the lack of infrastructure in some emerging markets. Should governments finally decide to improve these systems, it could push steel demand sharply higher.

Input Prices: Iron ore represents a significant cost for the steel industry. As prices rise for this important input, look for end steel prices to surge as well. As a result, it could squeeze margins for some of the less vertically-integrated firms in the sector, potentially hurting some stock prices.

Use of Substitutes: Technological advancements have made possible substitution of cheaper metals in certain applications. For example, carbon fiber has replaced steel in numerous transportation applications due to its high strength-to-weight ratio and comparable cost. Other metals, such as titanium and aluminum, can also be substitutes to some degree although the different chemical properties of these metals limits their usefulness in many applications.

Investing in Steel

Traders and investors can purchase exposure to steel as a commodity with everything from ETFs to steel futures to equities involved in manufacturing and selling the alloy metal. Deciding on the optimal way to invest in steel depends largely on the investor’s goals, risk tolerance and time horizon [see also For Day Traders: The Most Liquid ETF for Every Commodity].

The Chicago Merchantile Exchange (“CME”) Group offers a number of different steel futures contracts traded through the New York Mercantile Exchange (“NYMEX”), including Chinese Steel Rebar HRB400 (“Mysteel”), Steel Billet FOB Black Sea (“Platts”) and U.S. Steel Coil, providing broad exposure to different regions depending on investor preferences.

Perhaps the most popular option is U.S. Steel Coil futures (HRC), which trade in 20 short ton contract sizes in 24-month increments. European style futures options (HRO) are also offered on the commodity, quoted in price per ton with financial-only settlements, providing traders with additional ways to capitalize on the commodity’s price movements.

Investors can also build exposure to steel by purchasing equities engaged in manufacturing and selling the commodity. Like most commodity producers, the profitability of steel companies strongly correlates with global steel prices, although their movements tend to be greater in scope than the underlying commodity itself in many cases [see 5 Commodity Trading Mistakes You Could Be Making].

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